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VC funds hope to help early-stage life sciences firms

December 1, 2012

funds-facts.gifEarly-stage venture capital has been harder and harder to come by for life sciences companies in recent years, but two Indianapolis investors are working to raise sizable funds to help fill the gap.

San Francisco-based CMEA Capital is trying to raise $100 million for early-stage life sciences investments, according to multiple people who have been briefed by CMEA’s Midwest partner in the fund, Kent Hawryluk.

Hawryluk, who was a co-founder of the Carmel-based drug development firm Marcadia Biotech, will oversee Midwest investments of the fund from Indianapolis, with a focus on biotech and pharmaceutical companies, according to people familiar with his plans.

In addition, Oscar Moralez, managing director of the StepStone Angels network, plans to start pitching a new fund to investors early next year. His plans are to raise $10 million to $20 million to invest in technology companies, including life sciences firms, in Indiana and surrounding states.

“We feel the timing is right,” said Moralez. He described the fund he wants to raise as, in part, a "sidecar" to help the seven companies now supported by StepStone Angels—six of which are life sciences companies—to continue to get the cash they need to grow.

“It is an opportunity, for sure,” Moralez said of investing in early-stage life sciences companies, “because the reality is that a lot of the venture capital funds are no longer in existence; they’ve used up all their capital. And the new ones that are popping up are investing in later-stage companies.”

Life sciences entrepreneurs and investors already active in the market said they welcomed the possibility of tens of millions of new investment dollars coming on the scene.

“That would be a wonderful thing,” said Joerg Schreiber, a former manager at Roche Diagnostics Corp. who now leads the startup Indiana BioPharma LLC. “If someone like CMEA can bring money into our region, that can be beneficial.”

How early-stage either CMEA’s or Moralez’s funds end up being remains to be seen.

Hawryluk, who has been a partner in two previous venture capital firms, did not return messages seeking comment for this story. The CMEA website says Hawryluk will focus on commercializing technologies developed at Big Ten universities, which would include Indiana and Purdue universities.

Moralez, who himself raised early-stage venture capital when he was president of BioStorage Technologies Inc. in Indianapolis, said the strategy of his fund will hinge on who invests.

He intends to pitch the fund idea to the nearly 60 Indiana angel investors now involved with StepStone’s chapters around the state, as well as to other wealthy individuals who are more interested in the fund concept than in the time-consuming work of angel investing.

Either way, both funds would have their pick of the many cash-starved life sciences companies in and around Indiana.

“They will get a look at every deal,” said David Johnson, CEO of BioCrossroads, which runs its own seed fund for life sciences companies. “Not surprisingly, there are more early deals to look at than later deals.”

Indeed, the amount of money flowing into Indiana life sciences companies has tailed off since the financial meltdown four years ago.

Venture capital plowed into life sciences companies fell by half from 2009 to 2011, from $55 million to less than $28 million, according to statistics kept by the National Venture Capital Association, PricewaterhouseCoopers and Thomson Reuters.

Life sciences venture capital funding in Indiana—which includes biotechnology, medical devices and health care services—was on the same slow pace through the first half of this year, with less than $14 million invested.

Elevate Ventures, the private entity that now runs the state’s 21st Century Fund, has expressed a clear preference to invest in health information technology companies instead of medical-device or drug companies.

Even the funds that are active in life sciences have been holding off their investments until later and later.

When BioCrossroads announced its second seed fund earlier this year, it said it would make investments ranging up to $1 million, compared with a cap of $500,000 on its first seed fund, raised in 2005. The reason was that it could no longer count on other investors to come in as early as before.

“There aren’t many truly early-stage investors that will put in the kind of money involved that will get it over the next hurdle, to the next stage,” said David Doyle, CEO of Redox Reactive Reagents LLC, a company spun out of Franciscan St. Francis Health in Indianapolis that is developing a blood test to identify Alzheimer’s patients.

Investors are steering clear of early-stage life sciences firms for many good reasons, and those reasons aren’t going away anytime soon.

The U.S. Food and Drug Administration has raised its demands for the clinical trial data it needs to approve new drugs and medical devices, often hiking the amount of money companies need to conduct clinical trials or simply raising uncertainty about what kind of clinical results will be enough to get new products on the market.

At the same time, pressures in the federal budget have made it harder to get a lucrative reimbursement rate from the federal Centers for Medicare & Medicaid Services—which sets prices for new drugs and devices, which most private health insurers then use to set their own prices.

“There’s more financial risk for these companies,” said Greg Maurer, a managing director at Indianapolis-based Heron Capital, which manages a $25 million venture capital fund focused on life sciences companies. “But I don’t see a corresponding increase in the return potential.”

That new reality of higher risk but the same or even less potential for payouts is why most venture capitalists have migrated to making life sciences investments later in a company’s life cycle, when the risks have lessened somewhat.

Maurer also noted that, if venture capitalists do invest early in a company’s life, they have to keep investing in every other round of fundraising a company does, or risk having their stake in the company “punitively” diluted by later investors.

“You just want to make sure that you have dry powder available,” Maurer noted as one more reason venture capitalists prefer to invest at later stages.

Maurer expects this gap in early-stage funding to persist until there is more certainty about the risks at the FDA and at the federal Medicare program. And most other investors agree.

But Johnson, the BioCrossroads CEO, said he expects the next round of life sciences funds to raise money from investors with more stomach for the high-risk, high-return game of early-stage life sciences investing.

“There’s a lot of money sitting on the sidelines,” he said. “You’re going to get new funds put together by investors with a different appetite for risk.”•

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